With all of the risks inherent in a construction business, it’s important that you have sufficient insurance coverage. But you also need to keep policy costs under control. Captive insurance can be a great way to do both.
With captive insurance, you establish a subsidiary company to self-insure your business. Bigger companies may set up the arrangement independently, but a group of smaller businesses also can form a captive by banding together to buy insurance.
Because a captive serves fewer customers and is set up by the insured, it will naturally be more responsive than a large insurance company serving thousands of clients. As the insured, you may also be able to reduce the chances of future accidents by scrutinizing loss reports and being committed to follow up with managers to improve job safety.
Moreover, because you at least partially own the captive, premiums are easier to control and, in the absence of unanticipated liabilities, are likely to be lower and more stable in the long run. Plus, premiums can be determined by individual loss experience as opposed to industry group or other classifications.
Last, as the owner of the captive, you’ll benefit from any investment or underwriting profits achieved. Of course, by the same token, you’ll also bear the cost of any losses incurred under the program.
Setting it up
A group captive may be a viable option if your construction company has at least $200,000 in annual combined premiums. But the savings generally favor businesses with annual premiums in excess of $1 million for automobile, umbrella, general liability, property and casualty, and workers’ compensation insurance.
Under a group captive arrangement, companies pool financial, business and insurance risk into one self-insured retention level and buy an aggregate stop-loss policy. In buying the policy, each company commits itself to sharing a portion of the other parties’ liability.
Group arrangements can vary in rules and structure. Some captives require annual combined payments of as little as $50,000. Groups normally limit their size to 80 or fewer members, with some having fewer than 10 members.
Most captives are set up for property and casualty risks, so that claims tend to be larger and less frequent. Some companies may find that letting a captive handle only part of their risk and relying on traditional insurance for other areas makes sense. For instance, the high frequency and relatively small risks associated with health care are sometimes best managed through traditional insurance.
Companies that belong to a captive can generally deduct their premiums if they don’t control the captive. Tax courts have upheld a company’s right to deduct premiums paid to a captive it owns if the captive writes a significant amount of insurance for customers other than the parent company.
To take the deduction, the insured must be able to prove that risk was actually transferred. Blending conventional and captive insurance into a single policy is one way to transfer risk and qualify the entire policy for deductions.
The timing of loss deductions is also critical. Contractors generally prefer to take deductions in advance for expected losses. Keep in mind, though, that the IRS doesn’t want companies to deduct losses for self-insurance until claims are actually paid and the IRS can deny these deductions during an audit.
Finally, the location of a captive and the tax consequences of that location are also important to consider when choosing a captive. While many companies find locating their captive insurance companies in the United States advantageous, many group captive insurance companies are located offshore. This is because no taxes are paid on any of the members’ earnings as long as the money remains offshore.
Right for you?
Captive insurance is a comprehensive alternative to traditional insurance. With expert implementation and management, a captive insurance program can provide contractors an excellent way to manage risk and control costs.